Monday, 6 February 2017

October Cash Rate cut most unlikely with conditions stable in the money markets and negative real interest rates

It is no secret that the RBA look at a number of economic indicators when they go to board on the first Tuesday of each month (except January). What is a secret is the decision that they will make in the lead up to Tuesdays 2.30 announcement. The major factors that contribute to the RBA’s decision are clearly outlined on their website under the heading -What are the Objectives of Monetary Policy?. These objectives are:

‘Our view is that a flexible medium-term inflation target remains the right monetary policy framework for Australia. This was reaffirmed in the new Statementon the Conduct of Monetary Policy, which has also been endorsed by the Reserve Bank Board. The goal remains for CPI inflation to average between 2 and 3 per cent over time.’

The evidence of effectiveness to the economy when changes to the Cash Rate occur can be seen more immediately in the money markets and foreign exchange market. However, effects to inflation, employment and GDP are more medium-long term based, where the evidence does not come available until months later upon the data being released.

The evidence suggests that the recent adjustment of the Cash Rate to 1.50% on the 3rdAugust has stabilised the money markets, with the yield curve gaining a healthier shape and even 2 year CGS yields trading above the cash rate. Though, the AUD has remained high, the RBA failing in their quest to achieve a lower AUD to stimulate economic growth through rising exports and help to increase inflation to target levels through the rising cost of imports.

However, they have succeeded in achieving negative real interest rates; equal to the Cash Rate minus inflation.Core inflation (excluding volatile items)is the gauge that the RBA considers when making their decision on Monetary Policy, and this came in at a figure of 1.6% (Jun-15 to Jun-16) on the 27thJuly one week prior to the RBA’s August board meeting. This equates the Real Cash Rate to be -0.1% meaning when investors borrow money at 1.5%, their borrowing costs are lower than the rate of inflation, making it easy achieve a return on investment. Of course, this is theory based because only Authorised Australian Financial Institution have access to borrow money at the Cash Rate, but the idea is that it will translate into more profitable opportunities throughout the banking system and stimulate monetary expansion.

Conclusively, it is highly unlikely that the RBA will cut the Cash Rate again soon, in light of the stabilised of money markets and negative real interest rates. Both, outcomes of the August rate cut.